What do you do when it’s time to go?

Stan JohnsonEric Johnson

2013 Annual ConventionSeptember 25-27, 2013

Know When to Fold ‘Em

Things to think aboutBEFORE

Selling (or Buying) aBusiness

The Gambler by Kenny Rogers

• You got to know when to hold ‘em, know when to fold ‘em

• Know when to walk away and know when to run

• You never count your money when your sittin’ at the table

• There’ll be time enough for countin’ when the dealin’s done

Family Businesses Dominate

According to Business Beware a significant amount of small business stats were centered around family businesses:

The average life span of a family owned business is 24 years

The number of businesses run by women has grown 37% in the last 5 years

Family businesses comprise 80-90% of all small business enterprises in North America

Only 40% of family owned businesses survive to the second generation, 12% to the third and 3% to the fourth

Fail to Plan, Plan to Fail

• Why are we in here today?• How are you going to sell your company?• What are you selling?• How do you value it?• What are the terms?• Who is going to be your expert, advisor or

attorney?• Do you have a plan; a plan that keeps you

active?

Going Solo…Not!!!

• Please don’t think you can do this without strong support

• Yes, Virginia, there is a Santa Claus and it is NOT your buyer

• Details, details, details; take care of the details before you close or be sure to have a good lawyer after you close

• I’ve got to take care of my people• Wait until you see what your competition tries to

do to your customer base

Let an Expert Guide You

• If you had not had training on changing a compressor before you started changing them how many would you have burned up?

• There are many qualified merger and acquisition specialists; the bigger the company the more sophisticated the advisor

• Business brokers, accountants, attorneys; ask for references and check them out; interview more than one

• This person is helping you chart the rest of your life

Deciphering the Legalese

High-level walkthrough of the basic legal documents to discuss:•the process and the timing of a typical sale transaction; and•some of the big issues that you and the buyer will negotiate.

Confidentiality Agreement

• Usually the first agreement entered into between a seller and a potential buyer

• Preserve confidentiality of sensitive information, etc.

• Limit Buyer’s use of information to evaluating and negotiating transaction

• Return or destruction of information if negotiations are terminated

• Non-solicitation of employees

Letter of Intent (a/k/a the Term Sheet)

• Outline of parties’ current understanding of the deal terms (structure, purchase price, etc.) -- Non-binding

• Binding terms (cooperate in Buyer’s due diligence investigation, exclusivity, conduct business ordinary course, confidentiality)

• Seller’s maximum leverage is typically at the letter of intent stage.

• Make sure your lawyer is involved.

Purchase Agreement

• Structure (Stock Purchase vs. Asset Purchase vs. Merger)– Stock purchase is generally the seller

preferred structure– Buyer may push for asset purchase (successor

liability issues, tax benefits to Buyer)• Tax Treatment – talk to your advisors!;

every seller’s tax situation is unique; state tax treatment varies

Purchase Agreement• Assume stock purchase for cash (other options –

cash/stock mix, seller financing with a note, etc.)• Break down of a typical stock purchase

agreement:– the basic sale/closing provisions– “reps and warranties”– covenants– conditions to closing– termination provisions– indemnity provisions

Basic Sale/Close Provisions

• Shares to be sold• Purchase price to be paid by Buyer• Closing (timing; separate sign and close?)• Documents to be delivered at Closing• Purchase Price Adjustments – not included in every deal– often tied to working capital– interplay with indemnity (no “double dipping”)

Reps and Warranties

• “Representations” and “Warranties” are statements and promises regarding past, existing or future facts about your business (essentially, a formal description of your business organized by subject)

• Serve 3 Primary Purposes:– Diligence/Risk Allocation– Conditions to Closing/Termination– Post-Closing Indemnity claims

Reps and Warranties

• Subjects typically covered– organization and good standing– authority and enforceability; no conflict– capitalization– financial statements– books and records– real and personal property– condition and sufficiency of assets– accounts receivable

Reps and Warranties

• Subjects typically covered (cont.)– inventories– no undisclosed liabilities– taxes– employee benefits– compliance with law– litigation– absence of certain changes/events– material contracts

Reps and Warranties

• Subjects typically covered (cont.)– insurance– environmental matters– employee matters/compliance; labor disputes– intellectual property– relationships with related persons– customers and suppliers– product liabilities and warranties– brokers/finders

Reps and Warranties

• Seller would prefer no reps and warranties (“as is/where is” deal), but unrealistic absent significant Seller leverage or deeply discounted sale price

• Disclosure Schedules• Time qualifiers• Knowledge qualifiers• Materiality qualifiers

Reps and Warranties

• In an all cash deal, the Buyer’s reps and warranties to the Seller are limited:– authority and enforceability– any required financing in place for closing

Covenants

• Pre-closing covenants– Access for due diligence– Operate business in ordinary course– Cooperation on governmental and third party

notices and consents– Payoff of related party indebtedness– Exclusivity– “Efforts” standard (best efforts vs.

commercially reasonable efforts)

Covenants

• Post-closing covenants– Cooperation; Access to records– Noncompetition, Nonsolicitation and

Nondisparagement– Confidentiality

Conditions to Closing

• Accuracy of Reps and Warranties (“bring down”)

• Performance of all covenants• Receipt of consents and governmental

authorizations• No litigation challenging transaction• No Material Adverse Change (“MAC walk

right” – case law favors sellers but beware of objective conditions)

Termination

• How?– By mutual agreement– Material breach by other side and no cure

within prescribed time period– Conditions to Closing not satisfied– End Date

• Effect?– Walk away; “no further force or effect”– Termination fees and expense reimbursements

Indemnity• General contract remedies vs. indemnification

provisions (exclusive remedy)• For what?– Breaches of reps and warranties– Breaches of covenants– Other matters separately identified (taxes,

environmental, litigation, etc.)• Who is on the hook? Joint and several liability

issues.

Indemnity

• Limitations– Time (“Survival” and notice requirements)– Amount

• “Thresholds” (first dollar) and “Deductibles”• “Cap”

– “Offsets” for insurance proceeds– Purchase price adjustments (no “double

dipping”)– Exceptions or “carve-outs” from the limitations

Indemnity

• Escrow Agreement or “holdback”• Buyer setoff rights– Promissory notes– Earnouts

Earnouts

• Portion of purchase price is contingent upon achieving certain negotiated financial or non-financial performance goals.

• Solution to a “valuation gap”• Seems simple, but a difficult drafting

exercise (disputes – and litigation – are common)

• Tax issues – risk of ordinary income treatment if continued involvement

Employment/Consulting

• Can be beneficial to both Seller and Buyer• Issues:– Duties– Term– Comp./Benefits (Independent Contractor?)– Noncompetition– Beware of Buyer setoff rights– What if the Buyer sells your business? (change

of control payments?)

Post-Closing

• Closing your deal is just a new beginning:– Transition issues– Purchase Price Adjustments– Earnouts– Indemnity claims

Q&A

Any questions?